This is a guest post from David Blacher, Partner & Head of Media and Technology at RSM. RSM is a Tech Nation growth programme partner.
Employee equity incentives are a well-established part of the employee reward framework within the tech sector. For many employees and executives, share options and other forms of equity reward form a core and expected part of any remuneration package. This continues to be the case in the post-Covid-19 world.
In what has typically been a high growth industry, employee equity awards come in many shapes and sizes.
What should equity incentives look like?
The form of incentive that is most appropriate for a business will depend on a number of factors, for example:
- stage of development
- who is being incentivised
- the expectations of key stakeholders (eg existing shareholders, investors, and participants)
- KPIs and targets
- behaviours to be driven (ie encouraging employees to think like shareholders and adopt a common corporate culture)
For most businesses, all of these factors are likely to be impacted in some way by Covid-19.
The most common form of equity plans that we see in this sector are share options. These are ‘tried and tested’ offerings, providing benefits to both the participants and their employers. They are well-recognised by investors and other stakeholders and provide an opportunity to make awards on a discretionary basis. Employers can choose who participates, on what level and can set tailored performance conditions.
Where possible, options are typically granted under a tax-advantaged plan, such as Enterprise Management Incentive (EMI) or Company Share Option Plan (CSOP).
Using these plans, participants gains ought to be taxed under the capital gains tax (CGT) regime, which is currently* more favourable than income tax. Employers can often obtain corporate tax deductions when options are exercised.
Where tax-advantaged share options are not available, companies may choose to grant ‘non-tax advantaged’ share options instead. These offer a relatively simple alternative to the tax-advantaged share plans mentioned above, though don’t carry the same tax advantages for employees.
*Changes to capital gains tax. At the time of writing, UK capital gains tax seems to be firmly in the government’s line of sight for reform. Business Asset Disposal Relief (formerly Entrepreneurs’ Relief) has already seen a reduction in its available lifetime limit from £10 million to £1 million. Given the ongoing impact of the coronavirus on the public purse, further changes to CGT cannot be ruled out.
Alternatives to options
Companies may seek to implement something more bespoke, such as growth/hurdle shares (a newly created class of share with inherent rights attached) or partly paid shares (arrangements under which shares are acquired immediately, though are not paid for until a later date). Provided these are properly implemented, gains ought to be protected for capital purposes.
These forms of equity incentive are more complicated in terms of structure and will usually require amendments to the company’s constitutional documents such as its articles of association. Care should be taken in valuing shares with special rights attached and to make sure the arrangements ‘interact’ correctly with any shareholder or investment agreements in place. As a result, these more complex plans are typically used for more senior executives and may focus on the longer-term strategic objectives of a business or where the existing share capital does not deliver an effective incentive.
What are phantom plans?
It is not always suitable to incentivise employees using actual equity-based awards.
Nonetheless, it may be desirable to link employee incentives to metrics typically associated with share-based awards, e.g performance targets linked to share values.
Such arrangements are generally referred to as ‘phantom plans’. These are effectively cash-based plans (so subject to UK payroll taxes) that are intended to align the interests of the participants with the main shareholders.
What about international plans?
Many companies operate internationally with employees in a number of different countries. This can pose its own challenges and opportunities for equity incentives, as well as issues more broadly.
Practically speaking, it is usually simpler to adopt one plan and roll this out to employees internationally. That being said, there are some potential pitfalls that companies should be aware of.
From a regulatory perspective, award structures are likely to be subject to varying tax and compliance treatment in different jurisdictions. What may offer tax savings in one country, could result in unexpected charges in another. In this respect, it is always recommended to seek local advice before implementing plans to ensure there are no unexpected consequences or obligations for either the employees or for their employer company. Employees may also be recommended to seek personal advice.
In our experience, trying to achieve optimal treatment in all countries can be a complicated (and likely pricey) endeavour. Additionally, it is often not the key motivating factor for equity awards, which tend to be primarily focused on incentivisation, reward, ownership, and retention.
Instead, many companies choose to focus plan optimisation efforts in ‘core’ areas. This might be, for example, wherever the majority of plan participants are located. Subject to obtaining local advice this is often the least administratively burdensome approach. Separate arrangements can usually be put in place for senior employees if appropriate.
Navigating employee incentives can be a complicated business, but once you’re happy with your offering, it can be a major factor in attracting talent, leading your employees to feel they are part of something larger, and helping them to see a serious future in their role.
There are a lot of different choices available in terms of the form and substance of any employee incentive plan – a ‘one-size-fits-all’ approach generally will not work. What is best for your company and your employees will depend on what motivates your team, your overall objectives, and of course the potential returns. As a result of these factors, specialist advice is recommended to ensure you achieve the best outcomes for your team, and remain compliant with any requirements or obligations, as well as any legislative changes.